While the pace of the economic recovery since the 2008 has been subject to much debate, the fact is that the United States has clearly been on a growth trajectory for the last six years. Unemployment has dropped from a 2009 high of 10 percent to 5.9 percent, negative GDP has reversed and is trending at a 3.5 percent growth rate in 2014, the U.S. stock market is at an all time high, and interest rates at near all time lows. By most measurements, the U.S. economy is robust while Europe and other economies such as Japan are lagging. So why be worried?
The United States has a cyclical economy, impacted by world events and, more important, the global growth of consumer demand. On the negative side, the growth of consumer demand in China is slowing and wages are rising, Europe is worried about disinflation as consumers are out of the market and U.S. government support for stabilizing the economy appears to be ending. After six years of economic recovery, it’s time to think about the inevitable: there will be a recession and it’s not too early to think about how to prepare your company to survive and prosper during tough times.
Smart CEOs and boards are preparing today for a less robust economy. Here are five steps to take:
1. Hedge Your Bets!
Companies can turn to commodity derivatives to hedge raw material prices and assure adequate supplies. Commodity derivatives are contracts that draw their value from the price movements of an underlying asset. You can hedge the prices of oil, gas, coal, metals, agricultural products, and even electricity through commodity derivatives.
If you are a producer or supplier of these materials, recessions will likely push down prices and forward contracts can lock in your sales price — smart oil companies locked in high prices when the price of oil recently dropped from $100 barrel to $80.
The buyer of a futures contract benefits from an increase in the price of the underlying commodity. Contract sellers root for a decline in prices. (Consider seeking expert advice on how to structure transactions to prepare your company for a decline in prices.)
2. Swim the Channel
One of your most important assets is your sales channel and existing customers. To better position yourself in the coming downturn, consider using that channel to expand sales of new products and services. There are several strategies and methods to increase sales:
- Adjacency Strategy. Are there “adjacent” areas around the company’s core products or services that are natural extensions of the core? Examples might include a warranty or expedited delivery service offering to your existing product line.
- Extension Strategy. Extensions involve the concept of the “extended enterprise.” Consider reaching beyond natural adjacencies to product or service extensions that might position the company for growth beyond the core business.
- New Channel Strategy. Consider entering new markets through alliances, partnerships, mergers or acquisitions, or even franchising your product. Alliances and partnerships might be a less capital-intensive way of growing the company without having to make an investment in new production facilities or inventory.
3. OPM (Other People’s Money)
Most small businesses have some form of a line of credit: an agreement between a financial institution—generally a bank—and a borrower to provide a certain amount of loans on demand. Many banks today have more money than borrowers and report that only about 40 percent of the existing lines are drawn. Many businesses do go out of business during a recession and it is for one fact: they run out of capital. Consider increasing your line of credit and establish new credit facilities even if you don’t need them now. You may later.
Another strategy for increasing your company’s cash flow, critical in a downturn, is through a change in credit terms from your vendors and to your customers. For example, if your competitor pays their suppliers in 45 days and you pay in 30 days, you are leaving money on the table. Conversely, if your sales terms are overly generous, you will need to finance cash needs that could be met by better billing and collection practices. Lastly, determine if your suppliers are giving you their best deals.
4. Outsource Everything (that’s not strategic)
You are already a big user of outsourced services. You probably don’t deliver your product directly to your customer yourself, do your own audits or taxes, or self-insure your business. You may also outsource some or all of your manufacturing overseas. In an economic downturn, a key strategy is to convert fixed costs to variable costs — outsourcing is one way to do this.
Consider outsourcing everything that is not strategic to your business. This includes your HR support functions, accounting, manufacturing, transportation, and even your executive staff. Do you need a full-time CFO or controller, or would a “fractional” CFO or controller that is a shared resource with other companies work for you?
Most HR functions can and should be outsourced for small and mid-sized companies. A Professional Employee Organization (PEO) can help process your payroll and offer your employees a better offering of benefits. In addition, by pooling with other companies through a PEO, you can get significant discounts on the cost of benefits.
5. Understand Your Value
During the last recession, virtually every U.S. car company except one had to be bailed out by the government. The exception, Ford, saw the recession coming and sold and leased back their facilities, creating a war chest of capital to weather the recession. It might be reassuring to own your real estate, but if you are not a real estate company, consider reinvesting the capital tied up in your real estate into the production and growth side of your business.
A sale-leaseback is a transaction between a bank or investor and a company that sells and leases back its real estate or other fixed assets over a long term. It is more complex than a loan and involves many accounting issues, but you still use and control the facilities and you are effectively turning a non-liquid asset into a liquid asset, an important decision when times are tough.
Of course, the storm clouds of a recession might be far off, but being well prepared for bad weather is easier than weathering a storm with a leaky ship.
About Michael Evans
Michael Evans is Managing Director for the Newport Board Group, a partnership of board directors and senior executive leaders with deep knowledge of business strategy, operations, and capital markets. Previous to Newport, Michael L. Evans had been with Ernst & Young since 1977 and served as a partner since 1984. During his 34 years with the firm, he served as a tax, audit and consulting services partner, specializing in real estate companies and publicly traded entities. Michael served as the firm’s Global Director of the Real Estate and Construction Industry from 1988 to 1998, serving many of the largest international real estate organizations in the U.S. and the world. Michael is a frequent writer on business topics and has authored two books. He can be reached at (415) 990-1844 or via email at mievans@msn.com.
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